With the ECB’s QE coming to an end at the end of the year (absent some shock to the market or economy), some traders have already been voicing concerns which central bank will step in and provide a backstop to the global fixed income market, especially once the BOJ joins the global tightening bandwagon (something it will soon have to as Japan is rapidly running out of monetizable securities, and just moments ago the BOJ announced it would trim its purchases of bonds in both the 10-25 and 25+ year bucket).
Today one answer emerged when China’s central bank – three weeks after its latest RRR cut – announced further easing measures, including the introduction of incentives that will boost the liquidity of commercial banks, helping them to expand lending and increase investment in bonds issued by corporates and other entities.
And in a surprising twist, in order to make sure that Chinese banks and financial institutions have ample liquidity, the PBOC appears to have engaged in quasi QE – using monetary policy instruments such as its medium term loan facility (MLF) – to support the local bond market and banks, especially those that have invested in bonds rated AA+ and below. Effectively, China will directly fund banks with ultra cheap liquidity, with one simple instruction: “increase bank lending and bond purchases.” And since all Chinese banks are essentially state owned, what Beijing is doing is launching a form of stealthy QE, only one where it is not the central bank, but the country’s various commercial banks that do the purchases… using central bank liquidity.
As a reminder, one month ago we noted that the spread between China’s AAA and AA- rated bonds has spiked in the past three months, blowing out to levels not seen since August 2016, and an indication of the market’s growing fears about the recent surge in Chinese corporate defaults.
It is this spread, and other indications of bond market tightness that the PBOC wants to address using its MLF and the various other central bank lending facilities as tools for managing short- and medium-term liquidity in the banking system. It has to ensure that there is adequate liquidity especially with economic uncertainties, given the trade dispute with the United States. Indicatively, back in July 2014, when describing the PBOC’s Pledged Supplementary Lending facility, that we asked “Is this China’s QE“? We now have the answer.
And speaking of the MLF, in June, the PBOC lent out 663 billion yuan, or roughly $100 billion, to financial institutions via the MLF, with the outstanding MLF totaling 4,420.50 billion yuan at the end of June, up from 4,017.00 billion yuan at the end of May.
Commenting on the move by the Chinese central bank, Goldman said that this is a sign that the government is stepping up its loosening measures given the weakness in May and June TSF data, lukewarm June activity data, weak asset market performance, and rising trade tensions.
The catalyst for this quasi QE? Trump’s unexpected trade war escalation:
In our view, the government was likely surprised by the timing of the USD200bn tariff announcement by the US and is taking time to come up with a concrete response. While the direct hit to aggregate demand growth from weaker exports is likely to be fairly limited (still 0.5pp or less for the total USD250bn in goods related tariffs in three rounds: USD34bn+USD16bn at 25% and USD200bn at 10%) and can be relatively easily offset by policy loosening, the risk of further escalation and the potential effects other than the hit to export demand (e.g., negative impact on investment due to uncertainty) are significant and much harder to quantify.
Meanwhile, as we reported last Friday, the government already stepped up loosening in June, seen in the rebound in new yuan loan growth. However, off balance sheet non-loan TSF – and especially the record collapse in shadow – has become a bigger drag.
In this context, Goldman notes that any guidance to slow the pace of the decline in shadow banking would be an effective policy loosening tool as shadow banking remains the biggest binding constraint on TSF growth.
Going forward, Goldman expects the government to take further measures to ensure growth stability, including further RRR cuts, lowering the interbank rate, and, most importantly, administrative directives. Further, the bank notes that CNY depreciation is clearly a risk as well, and as we reported moments ago, perhaps in response to today’s directive, the Yuan is tumbling and is now 600 pips below what at the start of the month was said to be the PBOC’s “red line.” Clearly it wasn’t.
Yet while China’s further easing steps are hardly surprising – as trade tensions are intensifying it is clear that economic and market stability has become the short-term priority over controlling leverage, pollution, and property prices (here Goldman adds that “the key phrase in recent policy directives has been to avoid “one-cut” policy making – i.e., no uniform, across-the-board suspensions of infrastructure investment projects aimed at controlling debt, reducing industrial pollution, and limiting bank lending to reduce credit risk”) – the biggest risk is two-fold: at what point will China’s devaluation reignite the capital outflow observed between 2014 and 2016, when Chinese reserves declined by $1 trillion from $4 to $3 trillion to offset capital flight, and just how will Trump respond to what is now a clear, if implicit, currency devaluation using monetary policy tools?
Judging by the US president’s recent words and actions, sending Xi Jinping a congratulatory tweet over his handling of the economy will hardly be a priority; instead further tit-for-tat escalation is inevitable.